I participated in an interesting conference on Competition and Regulation in Financial Markets at the Bank of
England (co-organized by CEPR) earlier this week. Competition is with no doubt one of the most important, controversial but also broadest concepts in finance. While we teach our students in Introductory Economics the benefits of competition for
efficiency, resource allocation and innovation, there are quite some countervailing effects in finance. Many of these are related to information asymmetries (and thus the necessary incentives to create such information) and the limited liability character.
This has resulted in a long-standing paradigm that too much competition is detrimental to stability in banking, as it undermines franchise values and entices banks to take aggressive risks resulting in a higher failure probability. However, there are
opposing theories focusing on the effect of lower interest rates in more competitive banking system on reducing agency problems between lenders and borrowers and thus enhancing stability. The empirical evidence has not been clear cut, partly related to differences
in the measurement of both competition (market structure measures, behavioural measures or regulatory gauges) and fragility (market- or account-based, idiosyncratic or systemic).